Description

Executive Summary

At ~C$36 today, we believe the shares of GDI Integrated Facility Services, Inc. (“GDI” or “the Company”) – a Québec-based facility services provider with an ~C$850 million market capitalization – offer a compelling investment opportunity, with the potential for more than 50% upside over the next 18 months, and the prospect of further share price appreciation at attractive rates of return over a longer-term horizon.

• GDI is one of North America’s leading outsourced facility services providers, offering janitorial and technical services solutions to a variety of different commercial customers and property types.
• With a rich history dating back to 1926, the Company has grown both organically and through strategic acquisitions to become one of the few scaled incumbent providers in North America.
• Historically, GDI’s acquisition strategy has been “self-funding”; it has spent ~C$550 million to close 50 deals since 2008, relying on internally generated free cash flow as its primary funding source.
• The Company’s M&A activity has allowed it to successfully expand both in geographic terms and in the breadth of its services offering, and acquisitions to-date have proven to be highly accretive.
• GDI operates in a large and growing industry and, despite its relative size, has a mere single-digit share of a fragmented market, providing a long runway for further share gains and consolidation.
• From 2006 to 2022, the Company grew revenue at a ~22% CAGR and EBITDA at a ~24% CAGR; we believe its strong growth trajectory (both organic and inorganic) will continue well into the future.
• GDI’s long-time CEO, Claude Bigras, has been a strong operator and prudent capital allocator, and his ~11% ownership stake in the business helps ensure his alignment with shareholder interests.

Since July 2021, GDI’s share price has declined by ~40% and it currently trades at an 8.0x TEV / forward EBITDA multiple (vs. its 9.5x long-term average and the 11.4x it traded at only four years ago). This is primarily due, in our opinion, to a series of recent events that have hindered GDI’s free cash flow, causing some investors to believe that its “self-funding” acquisition strategy is now permanently impaired.

We have a variant view. We expect GDI to resolve these issues and resume its historically strong free cash flow profile in the near-to-medium term, positioning the Company to deliver on its 2025 targets. If it does so, we believe the Company’s valuation could quite easily return to its long-term average of ~9.5x forward EBITDA, which would imply a share price of ~C$58 by mid-2025 (representing a ~36% IRR or a ~1.6x MoM).

But, even at this higher level, we would continue to view GDI’s valuation as undemanding, given its history of profitable growth and continued prospects for the same. Therefore, as the Company’s fundamentals improve and more investors begin to study the story, we would not be surprised if GDI’s multiple were to re-rate higher still. In summary, we see this as a chance to purchase a proven industry consolidator with ample growth opportunities and an impressive operating track record at a discount to its intrinsic value.

Company Overview

Headquartered in LaSalle, Québec and listed on the Toronto Stock Exchange (“TSX”), GDI is one of North America’s leading providers of outsourced facility services to commercial properties. Typical customers are owners or managers of large buildings or specialized facilities, including office complexes, industrial or educational facilities, healthcare establishments, stadiums, hotels, shopping centers and airports.

Through its “Business Services” segment (~54% of revenue), GDI is the largest player in the janitorial services sector in Canada and is a leading player in the US, providing its clients with everything from routine cleaning to enhanced sanitation solutions. Through its “Technical Services” segment (~43% of revenue), the Company provides installation, maintenance, and repair of myriad control systems within its clients’ buildings, including HVAC, refrigeration, mechanical, plumbing, lighting, and security systems. This segment also offers remote monitoring, energy efficiency advisory and other ancillary services. Finally, through its “Corporate & Other” segment (~3% of revenue), GDI manufactures and distributes cleaning supplies, paper products / consumables, and other related equipment. In 2022, the Company generated ~56% of its revenue from Canada, with the remainder of its revenue stemming from the US.

GDI has a long operating history, dating back nearly a century to its initial founding as Robertson Janitorial in 1926. Some sixty years later, in 1987, Robertson was sold to Jean-Louis Couturier, who changed the Company’s name to Distinction Group. GDI’s current CEO, Claude Bigras, joined Distinction Group in the early nineties and began consolidating Québec’s commercial cleaning industry. Mr. Bigras became a major shareholder in 1998 and was named President & CEO in December 2004. A few years later, through a series of subsequent transactions, Distinction Group began trading on the TSX on November 23^rd, 2007.

Following its inaugural listing, Distinction Group continued to grow both organically as well as through select acquisitions, enabling it to further diversify its regional presence and the breadth of its services offering. Then, on November 21^st, 2011, it was announced that Birch Hill Equity Partners (“Birch Hill”) – a Toronto-based private equity firm – and Mr. Bigras would take the Company private as part of a ~C$153 million transaction. Distinction Group was formally delisted from the TSX on January 9^th, 2012.

The renamed “GDI Integrated Facility Services, Inc.” grew dramatically over the approximately three and a half years when it was private. To illustrate, in 2010, the last full fiscal year prior to the announcement, the Company generated ~C$260 million of revenue and ~C$16 million of EBITDA, with 9,000 employees across 17 offices in Canada. By 2014, GDI had grown to ~C$600 million of revenue and ~C$38 million of EBITDA, with 17,000 employees across 28 offices in North America (21 offices in Canada, and 7 in the US).

On May 14^th, 2015, GDI’s shares were relisted on the TSX following a reverse-takeover transaction. Since then, GDI has continued its impressive growth trajectory and, as of 2022, reported ~C$2.2 billion of revenue, ~$153 million of EBITDA and over 26,500 employees. In Canada, the Company has built the only nationwide and truly “integrated” facility services platform and is now 2.5x larger than its next closest competitor. And, with clients in 33 of the 50 states (and counting), GDI has built a commendable presence in the US – in relatively short order – through both healthy organic growth and nine strategic acquisitions.

Industry Backdrop

GDI’s market is large and growing. Over C$160 billion is spent on commercial janitorial and technical services in North America each year. That figure has grown at a ~3.1% CAGR since 2017, modestly outpacing GDP growth over the same period. The market is also highly fragmented, with thousands of sub-scale, local / regional players in operation. For context, while GDI is among the five largest providers in North America, it only has low- to mid-single digit share in both Canada and the US.

However, one must infer that with so many active participants, the commercial janitorial and technical services market has relatively low barriers to entry – and this is undoubtedly the case. But, what the market may lack in entry barriers, it makes up for in barriers to scale. For example, in the ~C$10 billion Canadian janitorial market, while there are at least six players in every major metro area with ~C$25 million of revenue, there are only three firms in all of Canada with revenue greater than C$150 million.

Two major factors combine to make scale so elusive in this industry. First, both janitorial and technical services are “labor intensive”; if a provider wishes to grow their business, they will invariably need to hire more people to perform the work. As a result, operating leverage is difficult to achieve, and when a provider’s profits don’t grow much faster than its revenue, expansion becomes hard to self-finance.

Second, while these services are not very “capex intensive”, they are fairly “working capital intensive” – especially at the start of a new contract, which often requires a provider to make an upfront investment in A/R. Generally, the working capital burden is ~7 – 8% of revenue for janitorial work and ~10 – 15% of revenue for technical services work. Couple this with the relatively low margin profile prevalent in the industry, and a provider may find itself willing to expand, but lacking the financial wherewithal to do so.

Consider a cleaning business in Greater Montreal with ~C$10 million of annual revenue that wishes to bid on a ~C$4 million RFP to provide janitorial services for the Bell Centre ice hockey arena. At the ~6% EBITDA margin typical of the industry, this business generates ~C$600K of run-rate annual pre-tax earnings, prior to any maintenance capital investments. If it were to win this ~C$4 million contract, the working capital burden alone (~7 – 8%, or ~C$280 – 320K) would cut its EBITDA for the year in half. In short, while this business may have the expertise to perform the work in question, it simply can’t afford to undertake it.

As a result of these factors, there is only a small handful of scaled, national providers in the ecosystem – of which GDI is one. And, we think it’s unlikely that many others will emerge from within the industry over the foreseeable future, due to certain secular trends currently benefitting the existing large incumbents. For example, as each year passes, a greater percentage of commercial real estate is owned by large institutions (e.g. REITs), who prefer to engage providers that have the geographic presence required to service a nationwide portfolio of properties, rather than just individual buildings in certain local markets. Additionally, property managers have increasingly begun to rely on “integrated” providers like GDI, who can satisfy a variety of their facility services needs (e.g. janitorial and technical services) and bill them all under a single invoice. Due to these trends, we think outsized benefits should continue to accrue to the scaled incumbents like GDI, providing a backdrop for further share gains and industry consolidation.

Acquisition Model

We believe GDI has a strong track record of reinvesting capital into attractive acquisitions. Initially, GDI’s M&A strategy was focused on geographic expansion, targeting commercial janitorial businesses outside of its core province of Québec to construct a leading, nationwide services platform in Canada. Once these foundations were laid, GDI then set sights on the much larger commercial janitorial opportunity in the US, entering the market through the purchase of Omni Facility Services (“OFS”) in late 2012. Commencing with the purchase of Ainsworth in November 2015, GDI also began utilizing its M&A capabilities to expand into adjacent – yet, complementary – market segments like technical services. Since then, the Company has entered other related verticals via acquisition, helping GDI evolve into a truly “integrated” provider.

Our channel checks suggest that GDI has emerged as a “consolidator of choice” for independent providers – both large and small – in search of a strategic partner. Compared to the typical sponsor-backed roll-up, GDI’s relatively decentralized management philosophy appeals to owner/operators who are looking to continue running their business as before, but who may be looking to monetize their ownership stake. Post-closing, the target’s owner and its employees will usually join GDI and maintain full P&L oversight, while receiving added support from corporate (often on request). Due to this “constructive” partnership approach, a large proportion of the acquisitions GDI has done to-date have been exclusive, bilateral deals.

As established earlier, given the thousands of potential M&A targets in the marketplace, GDI has been able to maintain a high degree of bidding discipline. Historically, it has paid between 4 – 6x EBITDA for smaller acquisitions (i.e. < C$100 million in annual revenue) and between 6 – 8x EBITDA for larger, more transformative transactions. While we aim to address the “appropriateness” of GDI’s valuation later, the Company has typically traded at an ~11x multiple of trailing EBITDA. Therefore, by purchasing businesses at half of GDI’s own multiple, the “valuation arbitrage” alone makes these deals immediately accretive.

Post-closing, GDI has demonstrated an ability to extract meaningful synergies. While the Company usually captures modest cost savings through centralizing certain back-office functions, it typically realizes more sizable revenue synergies. Once onboarded, a newly acquired business has access to additional financial “firepower” (e.g. working capital funding) and an improved reputational clout to take on more – and larger – contracts than before. The 2012 acquisition of OFS (which marked GDI’s entry into the US) provides a glimpse into the magnitude of the revenue synergy opportunity at hand. Our fieldwork suggests OFS had revenue of US$35 million at closing, which grew organically to over US$100 million roughly five years later.

Bringing this all together, we’ll briefly return to the example of the small janitorial provider in Montreal and the Bell Centre RFP. Recall that, with ~C$10 million of revenue at a ~6% margin, the business would need to earmark ~50% of its annual EBITDA simply to cover the required working capital investment, making it difficult for the provider to bid for this contract as a stand-alone entity. Imagine, however, that GDI acquires them for the 4 – 6x EBITDA multiple it typically pays for businesses of this size. Now, as part of GDI, not only does the provider have the financial backing it needs to bid for the contract in the first place, but it also has the reputational backing of a scaled, national incumbent to help it win. If (or when) the provider does win, the effective purchase multiple GDI paid falls even further (from 4 – 6x to 3 – 4x).

Lastly, but quite importantly, we are impressed by the “self-funding” nature of GDI’s acquisition strategy. Since 2008, the Company has completed 50 transactions for an aggregate consideration of ~C$550 million. All the while, GDI has maintained a net leverage ratio below 3.1x and has issued no new equity, instead relying on internally generated free cash flow as its primary funding source. Interestingly, almost all of the most successful – and lucrative – consolidation stories we’ve studied tend to exhibit this critical tenet.

Notwithstanding its acquisitive history, GDI has also demonstrated a sustained ability to grow organically. Over the last five years, the Company has achieved an average annual organic growth rate of 4.3%, which compares favorably to the 3.1% growth rate for the broader commercial janitorial and technical services market over the same period. To us, this also speaks to the true power of GDI’s acquisition model – namely, that the “full potential” of the businesses it buys seems to be unlocked after they become part of the consolidated company. In summary, we believe that GDI is a rather uniquely advantaged acquiror.

Future Growth Prospects

In our view, GDI has been a remarkable growth story – between 2006 and 2022, the Company’s revenue and EBITDA have increased at a ~22% and ~24% CAGR, respectively. Importantly, this impressive growth trajectory is not entirely “front-end loaded”; both revenue and EBITDA more than doubled in the five-year period from 2015 to 2020, and management currently expects a similar outcome for the five-year period from 2020 to 2025. And, while it might take a bit longer than five years for GDI’s revenue and EBITDA to double again from there, we have every reason to believe that it can, given the mere single-digit market share it would lay claim to in both Canada and the US if management’s current 2025 targets are achieved.

Looking ahead, we see numerous value-enhancing sources of future growth for GDI, arising from both organic and inorganic opportunity sets. First, we expect the Company to continue its attractive acquisition strategy, which has historically proven to be highly accretive to earnings. While GDI has been an active consolidator for many years, there is no shortage of additional M&A targets for them to pursue, given the thousands of independent janitorial and technical services providers still remaining in the marketplace.

Second, as mentioned previously, the prevalence of certain structural tailwinds in the industry are likely to help GDI supplement its M&A strategy with a healthy, above-market organic growth profile for years to come. These themes include, among others: (i) an increased proportion of commercial real estate owned by large institutions each year, (ii) a trend towards further outsourcing of facility services, and (iii) an increasing preference on the part of property managers to work with “integrated” services providers. Because of these secular trends, we expect more share migration towards the existing scaled incumbents like GDI. Additionally, as the “big get bigger”, this should further hasten the pace of industry consolidation.

Lastly, much like GDI’s foray into the technical services arena in 2015, we believe the Company may choose to enter other adjacent – yet, complementary – business verticals over time. Whether it develops these capabilities internally or through acquisition, GDI believes that the more encompassing its offering becomes, the more appealing its value proposition will be for both new and existing customers alike. The acquisition of Énergère in January 2022 is a textbook example of this, allowing GDI to quickly establish itself as a leading provider of turnkey solutions in energy and greenhouse gas reduction for building owners. We see no shortage of opportunity for GDI to expand its suite of services in the coming years, and ultimately believe it can act as a single point-of-contact for nearly all aspects of facility management.

Leadership & Ownership

For nearly two decades, GDI has been led by CEO Claude Bigras, who thus far has proven to be both a strong operator and prudent capital allocator. Mr. Bigras has worked his entire life in the facility services industry and joined GDI’s predecessor company, Distinction Group, in 1994; he was named CEO in 2004 and has been in this role ever since. From 2006 to 2022 (as prior financials are unavailable), Mr. Bigras oversaw a ~25x increase in revenue and a ~32x increase in EBITDA, stemming from a combination of healthy organic growth and 50 select acquisitions. During this period, he also proved to be a strong balance sheet steward, utilizing only modest leverage levels in pursuit of GDI’s consolidation strategy. Additionally, Mr. Bigras proved to be an adept “crisis manager” during the GFC; between 2007 and 2010, he grew GDI’s revenue, EBITDA and free cash flow each year – all the while, maintaining strong margins.

Importantly, we also believe Mr. Bigras has demonstrated an ability to deliver on GDI’s long-term targets. At its May 2015 relisting, the Company issued plans to achieve between C$1.5 – 2 billion of revenue within a five to seven-year timeframe at EBITDA margins commensurate with past performance (~6.5%, implying ~C$100 – 130 million). This compared to the ~C$600 million of revenue and ~C$38 million of EBITDA that GDI reported in 2014. Roughly six years later, GDI had hit its goal, reporting revenue of ~C$1.6 billion and EBITDA of ~C$133 million in 2021. This gives us confidence in Mr. Bigras’ ability to deliver on GDI’s current long-term targets, which call for ~C$3 billion of revenue and ~$200 million of EBITDA by year-end 2025.

In our view, Mr. Bigras has also exhibited an “investor’s mindset” when it comes to capital allocation. The Company has eschewed paying a dividend (despite continued calls for one, given its historically strong free cash flow profile). Instead, it has chosen to direct all excess cash towards further M&A, given the high return prospects these deals currently offer. Additionally, GDI recently enacted an NCIB program to take advantage of moments when the market serves up attractive opportunities to repurchase its own shares.

Finally, we are encouraged by the level of insider ownership at GDI. Mr. Bigras owns ~11% of the Company, and other NEOs and directors own ~28% (primarily through the “plurality” stake still held by Birch Hill, where GDI’s Chairman – Dave Samuel – serves as a partner at the firm). Of course, a limited float results in less liquidity, so the stock might be difficult for large institutional investors to own in size. That said, GDI tends to be a “low- to no-news” stock intra-quarter, and volume usually inflects higher around earnings events, providing investors with more liquid trading windows. However, we think any liquidity issues are more than compensated for by the high degree of shareholder alignment at GDI.

Discounted Price

At ~C$36 today, GDI’s share price has fallen ~40% from its “pandemic-era” peak of ~C$60 set in July 2021. We believe there are two reasons for this decline – with the second being the most important contributor:

1) Margin Normalization

Unsurprisingly, GDI was a clear COVID beneficiary, particularly on the “Business Services” – or janitorial – side of the house. During the pandemic, as property managers struggled to maintain a contagion-free environment within their facilities, GDI’s customers increasingly relied on them for enhanced sanitation solutions. This heightened level of service – e.g. daily disinfection of elevator banks, lobby areas and common spaces – was never planned for when these initial contracts were struck. As a result, GDI earned a very tidy profit for this extra work, leading to meaningful margin expansion. To further contextualize the degree to which it was over-earning at the time, GDI’s “Business Services – Canada” segment reported a ~16% EBITDA margin in the first quarter of 2021, compared to a ~7% margin in the first quarter of 2019.

From the beginning, management remained consistent in its communication with investors that GDI’s “Business Services” margins should revert to more normalized levels once COVID became “endemic” and demand for enhanced cleaning subsided. Further, in March 2021, when the Company first introduced its long-term targets for 2025, management again reiterated this belief. Their initial plan called for revenue of C$2.7 – 3.0 billion (with 3 – 6% organic and 10 – 15% inorganic growth per year) and EBITDA of C$180 – 200 million, implying a full reversion to GDI’s pre-pandemic blended margin profile of between 6 – 7%.

However, over the quarters to come, the Company’s “Business Services” margins remained elevated – especially in Canada – as demand for these COVID-related services lasted longer than expected. Additionally, as management continued to observe how their janitorial business was operating in the post-pandemic world, they began telling investors that margins might normalize at modestly higher levels than they initially anticipated. This was due to efficiency gains GDI began experiencing as some of its clients adopted “hybrid work” schemes; lower occupancy (e.g. 1/5^th of employees working remotely on any given day) was allowing the Company to provide the same level of cleanliness while utilizing less labor to do so.

While “higher margins for longer” was fundamentally a positive for GDI, we believe (i) the lack of visibility on the ultimate timing of its inevitable margin normalization, coupled with (ii) uncertainty around the exact level at which its margins might normalize, kept many investors – especially those new to the story – on the sidelines. We empathize in part, knowing how difficult it is to get excited by a business whose margins are contracting rather than expanding. However, as we sit here today, our view is that GDI’s janitorial margins have indeed reached their “new normal” – a view echoed by the Company on its Q3 2023 earnings call. Importantly, with “Business Services – Canada” now expected to remain within the 8 – 10% EBITDA margin range going forward, GDI’s profitability is settling at a higher level than where it was pre-pandemic. And, while management intimated that this scenario was possible, it was never reflected in GDI’s 2025 targets.

2) Diminished Free Cash Flow

Historically, GDI has been highly cash generative. From 2015 to 2021, the Company converted an average of 40% of EBITDA to free cash flow each year, the majority of which was used to fuel their M&A engine. Recently, however, cash conversion has moderated – in fact, it has turned negative (-6%) on a trailing 12-month basis as of Q3 2023. As we will expand upon later, we think this is the primary cause for the multiple contraction witnessed over the last few quarters. In short, investors have begun to question whether the “self-funding” nature of GDI’s acquisition strategy remains intact and have punished the stock accordingly.

We believe the “Technical Services” – or Ainsworth – segment is the true culprit driving this abrupt trend-change, and the key explanatory variable is the business’ evolving revenue mix. Ainsworth performs both project work (e.g. large-scale HVAC or other building system installations and retrofits) and service work (e.g. scheduled maintenance and repair or on-call “break-fix”). Prior to the pandemic, revenue was split almost evenly between these two activities. However, in recent quarters, project work has been growing at a faster rate than service work, and now represents roughly two-thirds of the segment’s total revenue.

The reason for this outsized growth is similarly COVID-related. Due to the nationwide lockdowns in 2020 and 2021, coupled with supply chain disruptions in 2022, it was difficult for the Company to perform these projects in a timely manner, which led to an inflated backlog. Once these challenges were behind them, GDI shifted into high gear to deliver on those projects that were previously delayed. However, the “recency effect” from long lead-times during the pandemic caused GDI’s clients to engage them on future project work earlier than before. As a result, GDI’s backlog has been in a constant state of replenishment.

Again, while “record project backlog” is fundamentally a positive for GDI, it has also come with adverse ramifications for the Company’s free cash flow. First, project work is typically a lower-margin activity than service work, so this outsized revenue growth has not translated into equally outsized earnings growth. Second, and more importantly, given the nature of the projects themselves (which can often last many months between planning and completion), the cash cycle is typically much longer than it is for service work. Because of this, GDI’s working capital burden increased substantially – from 9.4% of revenue in Q3 2021 to 12.7% of revenue in Q3 2022. And, for a business with single-digit EBITDA margins in the first place, the sheer magnitude of this increase severely hindered GDI’s ability to convert its earnings to cash.

In our view, the market dynamics responsible for the mix-shift in GDI’s “Technical Services” revenue – and the initial cash crunch that ensued – were generally outside of management’s control. However, we also believe that management lacked the appropriate urgency in addressing this issue when it first reared its head over a year ago. Given the supportive demand backdrop, we think that GDI had the flexibility to (i) take on new projects at higher margins than before, and/or (ii) require more favorable working capital terms from customers – two tactics that many of its “Technical Services” peers implemented successfully. However, because management was slow to adapt, GDI’s cash conversion woes worsened as rising interest rates started taking a toll on the Company’s 100% floating-rate capital structure. Due to a lack of excess cash for debt paydown, GDI’s interest expense has increased, which has further pressured free cash flow.

We are optimistic, however, that GDI’s cash conversion will improve over the coming quarters. First, we’ve noticed a marked “change in tone” in the Company’s recent commentary around cash management. For example, on its Q3 2023 earnings call, GDI introduced a hard target to reduce DSOs by “four to five days”, highlighted opportunities to “reduce WIP” by improving the cadence of project billing and intimated it will “be more aggressive” on Ainsworth’s margins going forward. Second, the market dynamics that drove the outsized growth in GDI’s project revenue seem to have since moderated. As the Company anniversaries its dramatic backlog expansion and actively reorients itself towards service work, we think Ainsworth’s revenue mix can come back into natural equilibrium, thereby alleviating some of GDI’s working capital drag. Finally, having recently closed a large acquisition in its “Business Services” segment (Atalian USA), GDI will likely focus on debt paydown as it integrates this asset, further helping its cash conversion efforts.

Now, with management more focused and market headwinds subsiding, we think GDI is well-positioned to improve cash conversion in the near-to-medium term and reignite its powerful “self-funding” strategy.

Valuation Considerations

Today, GDI trades at an 8.0x multiple of consensus forward EBITDA, ~17% below its 9.5x long-term average and near the bottom of its 7.5 – 12.2x range since its 2015 relisting. In the aftermath of the pandemic, the Company traded closer to 11x; certainly, it could be argued, the heightened focus on cleanliness that drove GDI’s janitorial margin expansion helped to propel its average valuation levels higher. However, we do not believe that the multiple contraction witnessed since then has much to do at all with either (i) the “pandemic” becoming “endemic” or (ii) GDI’s janitorial margins normalizing from their elevated levels.

As evidence to this, let’s compare GDI today versus GDI four years ago. In Q3 2019 – immediately prior to the pandemic – GDI was valued at 11.4x, much higher than its 8.0x current multiple (and higher than its “post-COVID” average, as well). Since then, the Company’s revenue and EBITDA have both nearly doubled, and while its share count has increased by ~9% (due to stock-based compensation), GDI’s market capitalization has only increased by ~16% over the period. So, what is the explanation for this disconnect?

In our view, it’s not “the industry” and it’s not “the market”, as relevant peer and index valuations are either flat or up versus four years ago. Additionally, it does not appear to be due to a change in GDI’s growth or profitability. On a trailing basis, the Company’s revenue growth and margin profile look identical to Q3 2019, while on a forward basis, sell-side analysts are currently expecting the Company to deliver higher revenue growth and margins than they were expecting back then. We believe the key difference is GDI’s cash conversion, which – as said previously – has recently turned negative, compared to the ~33% it had reported in Q3 2019; this lack of free cash flow control, in turn, has driven modestly higher net leverage (from 2.6x to 3.1x today).

In summary, we believe GDI is trading at an undemanding valuation because some investors believe its “self-funding” acquisition strategy is now permanently impaired. As such, if we are correct that cash conversion is poised to improve over the near-to-medium term, we think it is reasonable to expect that GDI’s multiple will re-rate higher to reflect this improvement. And, in our view, the Company's multiple could quite easily return to its 9.5x long-term average under this scenario.

Lastly, we thought we’d share our thoughts on the “appropriateness” of GDI’s valuation (both current and historical) in the context of other comparable companies in the marketplace. While GDI has no perfect public peers, a sampling of similar outsourced facility services providers shows that the average business in this cohort (i) has grown its revenue and EBITDA much slower than GDI over the last five years (~8% and ~12% CAGRs vs. ~18% and ~21% CAGRs, respectively) and (ii) is expected to grow its revenue and EBITDA at roughly half the rate of GDI’s through 2025, assuming the Company delivers on its current targets. Despite this, the market is ascribing the average business in this cohort a much higher multiple – or ~13x forward EBITDA. In our view, it is rare to find a business like GDI – with such an impressive history of growth and continued prospects for the same – trading at a single-digit multiple of earnings. So, we would not be surprised if the Company saw a more material multiple re-rating (above its 9.5x long-term average) as more investors study the story.

Scenario Analysis

We believe that GDI’s share price is suffering from a bout of “short-termism”, given how abruptly its cash flow challenges materialized. While we do not fault shareholders for being anxious to see these issues promptly addressed, we also believe that some investors may now be missing the forest for the trees.

As mentioned, GDI successfully delivered on the long-term targets it introduced around its May 2015 relisting, and we expect the Company to do so again when it comes to its 2025 targets. In fact, at GDI’s Annual Meeting in May 2023, management appeared confident enough in their ability to deliver that they updated their 2025 targets to ~C$3 billion of revenue and ~C$200 million of EBITDA – the high-end of the range they initially provided in March 2021 when the plan was first presented. We think that if GDI achieves its 2025 targets (or even comes close), its share price will invariably inflect higher from here.

However, the question becomes, “Given GDI’s recent issues, are its 2025 targets still achievable?” That is what our illustrative operating scenario attempts to address – to be clear, it should not be construed as a “bull”, “bear” or “base” case; rather, it should be viewed as more of a “feasibility assessment”. Further, due to the uncertainty around certain inputs like the size and/or timing of future M&A, this scenario is highly unlikely to play out exactly as described, but we hope it will prove to be directionally accurate.

Our key assumptions include:

• Full-Year 2023E – revenue of ~C$2.46 billion, EBITDA of ~C$145 million (at or modestly below current consensus estimates).
• Organic Growth – ~4% in both 2024 and 2025, at or modestly below the mid-point of GDI’s target range of 3 – 6% per year (“Business Services – Canada”: 3%, “Business Services – USA”: 4%, “Technical Services”: 5%)
• EBITDA Margins – 6.1% in 2024, 6.4% in 2025 on a blended basis (“Business Services – Canada”: 9% in 2024 and 2025 (mid-point of 8 – 10% range); “Business Services – USA”: 7.3% in 2024, 7.5% in 2025 (at or below 2019 levels); “Technical Services”: 5.7% in 2024, 6.1% in 2025 (vs. 5.8% in 2019) due to more favorable contract terms, improving revenue mix, modest operating leverage).
• NWC, % of Revenue – 11.8% in 2024, 11.0% in 2025 (vs. 12.6% in 2023E, 9.5% long-term avg); with our capex / tax / interest estimates, this drives 38 – 40% cash conversion (vs. 40% long-term avg).
• M&A – one deal in mid-2024 (“Business Services – Canada”), two in 2025 (one in “Business Services – USA”, one in “Technical Services”), each ~C$80M in revenue; purchased at 7x EBITDA, higher than the 4 – 6x GDI typically pays for deals of this size.

Using these inputs, we arrive at ~C$3.0 billion of revenue and ~C$193 million of EBITDA in 2025. So, we believe if GDI (i) grows organically in-line with past precedent, (ii) maintains its Canadian janitorial margins around the “new normal”, and (iii) exhibits better free cash flow control, the Company will again be positioned to "self-fund” its acquisition strategy, allowing it to deliver results in line with its 2025 targets.

If GDI does deliver these or a similar set of results, we think its valuation is likely to see a re-rating. Applying GDI’s 9.5x long-term average forward multiple to our 2025 EBITDA projection would imply a total enterprise value of ~C$1.83 billion. Combined with some modest deleveraging (net debt of ~C$422 million from ~C$438 million today), we see a path for GDI’s share price to increase to ~C$58 by mid-2025 as the visibility on its full year run-rate trajectory becomes clearer. This represents a ~36% IRR or a ~1.6x MoM.

While wary of formally underwriting any further multiple expansion, we do think that as GDI’s results improve and more investors study the story, it may again garner a valuation more typical of a high-growth, high-performing facility services provider. Recall, comparable companies that are growing much slower than GDI trade at ~13x forward EBITDA. Also, as recently as Q3 2019, GDI traded at 11.4x forward EBITDA, and the only fundamental difference between then and now is the Company’s free cash flow challenges. If these issues are resolved, we see no reason why GDI’s multiple shouldn’t return to that level (or higher). At the 11.4x multiple GDI traded at four years ago, this would imply a share price of ~C$72 by mid-2025.

Lastly, if GDI simply delivers on its 2025 targets (or comes close), we believe its stock price should increase based on fundamentals alone. Even at today’s 8.0x multiple, this would still imply a share price of ~C$45 by mid-2025. And, from a downside protection perspective, the Company’s current valuation is close to the low-end of its historical trading range – of course, this doesn’t exclude the possibility of further multiple compression from here, but it certainly gives us comfort about owning GDI’s stock at these levels.

Risks & Mitigants

#1 – Due to COVID-19, the “work from home” trend becomes permanent and office buildings remain vacant or occupancy levels remain depressed, which reduces demand for GDI’s services in perpetuity.

• Office makes up only ~15% of GDI’s “Business Services – USA” revenue, which is a relatively small number. While ~30% of GDI’s “Business Services – Canada” revenue is tied to office, it is nearly all Class A. So, if the current tenants don’t stay, these prime locations will likely get filled by someone.
• GDI’s “Business Services – Canada” segment’s EBITDA margins have expanded due to its office clients’ “hybrid work” schemes, which should help offset the impact of any modest revenue loss.
• Due to its flexible cost structure, GDI can relatively easily change the scope of work for a building owner / tenant if a client needs to find savings – and can do so all while preserving its own margin.
• In our view, GDI’s “Technical Services” business would likely not be impacted as much by this – for example, if a building’s HVAC system breaks, it needs to be fixed regardless of occupancy level.

#2 – A broad economic recession could occur, resulting in corporate / industrial distress which then leads to widespread business failures, thereby negatively impacting demand for GDI’s facility services offering.

• We believe demand for janitorial and technical services is fairly “recession-resistant”; no matter the macro backdrop, buildings still need to be cleaned and their systems need to be maintained.
• GDI’s operating performance during the GFC was relatively strong; between 2007 and 2010, its revenue, EBITDA and free cash flow grew each year, and it was able to maintain healthy margins.
• In both “Business Services” and “Technical Services”, GDI’s flexible cost structure allows them to engage with clients to change the scope of work so it can still perform well in a weaker economy.
• In a recession, deal multiples might start to compress, potentially allowing GDI to accelerate its M&A activity and close on more transactions for better businesses at more attractive valuations.

#3 – GDI’s value creation engine relies, in part, on further M&A activity – the opportunity set could dry up, deal multiples could rise, its cost of capital could (continue to) increase, or integration issues could set in.

• Given the fragmentation in the North American commercial janitorial & technical services market, we believe there is no shortage of acquisition targets for GDI to pursue for the foreseeable future.
• If multiples begin to migrate higher, so should GDI’s, thereby preserving its “valuation arbitrage”.
• We have no uniquely informed view of where interest rates are headed, but if GDI improves its free cash flow profile, we believe it can pursue further acquisitions and de-lever at the same time.
• Due to its decentralized model, we think GDI faces less integration risk than typical consolidators.

#4 – Birch Hill may decide to sell down its ownership stake, which could further depress GDI’s share price.

• In June 2020, Birch Hill announced it was rolling its investment in GDI from its old “Fund IV” into a new “Fund V”, which we think has the multi-year tenor typical of a new private equity fund (5+).
• Of course, Birch Hill could decide to monetize its stake early, which might pressure the stock in the short-term; however, we believe the additional “float” created would be a long-term positive.

#5 – As GDI’s CEO, Mr. Bigras has overseen much of its success to-date and may present “key-man” risk.

• Certainly a concern – however, Mr. Bigras is only 60 years old and, given his ~11% ownership stake in the business, likely has the vast majority of his net worth aligned with GDI’s continued success.

Catalyst

1) Improved free cash flow generation.

2) Margin normalization / stabilization.

3) Achievement of 2025 revenue and EBITDA targets

4) Multiple expansion as fundamentals improve and more investors study the story.